Hungary’s Tax Cut to EU’s Lowest Seen Risking Race to the Bottom

Hungary’s plan to cut its corporate tax rate to the lowest in the European Union from next year may spark a “race to the bottom” as its ex-communist peers look for ways to compensate investors for rising wages, according to BMI Research, a unit of Fitch Group.

Wage pressures are set to intensify next year as central Europe combats a labor shortage while workers flock to higher-paying jobs in the continent’s west, according to an e-mailed report released by BMI on Monday. The car industry, which acts as the engine of economic growth in much of the region, is particularly affected, it said.

“Labor shortages and wage increases are now plaguing a number of major” central and eastern European “countries and acting as a significant risk to their overall economic growth outlooks,” BMI said. “Given that these countries aggressively compete with Hungary to win auto investment contracts, there is a high chance that they will begin offering similar tax incentives to remain a competitive location for foreign direct investment.”

Hungary will cut the corporate levy to 9 percent from January and plans to lower payroll taxes to help companies boost salaries by as much as 40 percent in the next six years as authorities look beyond an economic model based on cheap labor, Prime Minister Viktor Orban said last week. Foreign carmakers from Volkswagen AG to Kia Motors Corp. are among the manufacturers that have transformed central Europe into a powerhouse for car production.

Aging populations from Poland to Romania and the exodus of skilled workers to the more affluent west, combined with a lack in investment, are calling into question the prospects of a region with a combined economic output of more than $1 trillion. The International Monetary Fund warned this month that some of the EU’s fastest growth rates may be difficult to sustain unless governments step up reforms to boost productivity in economies that already operate close to their potential.

All six countries in the region that released flash estimates of third-quarter gross domestic product last week reported that annual expansion slowed from the previous three months.

Hungary’s system of taxing companies currently imposes a levy of 10 percent for profits of up to 500 million forint ($1.7 million) and 19 percent above that.

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